bull call spread options strategy

Submitted by admin on Thu, 11/25/2021 - 20:21

To help pay for the expense, this method involves buying one call option and selling another at a higher strike price.


A vertical spread, such as a bull call spread, is a sort of vertical spread.
There are two calls with the same expiration date but distinct strikes in it.
Because the strike price of the short call is higher than that of the long call, this approach will always necessitate an upfront investment (debit).
The main goal of the short call is to assist cover the upfront cost of the long call.


The bull call spread functions similarly to its long call component as a standalone strategy up to a specific stock price.
The upward potential is capped, unlike with a simple long call.
That's part of the tradeoff; the short call premium lowers the overall cost of the plan while also limiting the profit potential.


A other set of strike prices could work, as long as the short call strike is higher than the long call strike.
It's all about balancing risk/reward tradeoffs and making a credible projection.

 

EXAMPLE

  • Long 1 SPY  400 call
  • Short 1 SPY  420 call

 

GAIN MAXIMUM


Net premium paid for high strike vs. low strike


LOSS MAXIMUM


Payment of the net premium


A greater short call strike provides a bigger maximum profit possibility for the strategy.
The drawback is that the higher the strike price of the short call, the lower the premium obtained.


It's worth contrasting this strategy with the bull put spread.
Once the net cost to carry is factored in, the profit/loss payout profiles are identical.
The primary distinction is in the timing of the cash flows.
The bull call spread necessitates a known initial outlay in exchange for an unknown eventual return, whereas the bull put spread generates a known initial cash inflow in exchange for a probable outlay later.

Outlook


During the life of the options, look for a steady or rising stock price.
The investor's long-term projection for the underlying stock isn't as critical as it is with any limited-time strategy, but this is probably not a good pick for those who have a bullish perspective beyond the near future.
To pinpoint the turning moment where a coming short-term drop would turn around and a long-term rise will begin, an accurate forecast would be required.

Summary


To help pay for the expense, this method involves buying one call option and selling another at a higher strike price.
The spread normally profits if the stock price rises, just like a traditional long call strategy would, until the short call stops further gains.

Motivation


Profit from a rise in the price of the underlying stock without the upfront investment or risk of outright stock ownership.

Variations


Depending on how the strike prices for the long and short positions are chosen, a vertical call spread can be a bullish or bearish strategy.
For the bearish counterpart, see bear call spread.

Maximum Loss


The greatest loss is extremely restricted.
The worst-case scenario is for the stock to expire below the lower strike price.
In that instance, both call options expire worthless, and the loss is limited to the initial investment (the net debit).

Maximum Gain


Should the stock price perform even better than expected and exceed the higher strike price, the maximum gain is capped at expiration.
At expiration, if the stock price is at or above the higher (short call) strike, the investor would theoretically exercise the long call component and be assigned on the short call.
As a result, the stock is acquired at a lower price (long call strike) and sold at a higher price (short call strike).
The difference between the two strike prices, less the initial outlay (the debit) paid to construct the spread, is the maximum profit.

Profit/Loss


This strategy's potential profit and loss are both highly limited and well-defined: the net premium paid at the outset establishes the maximum risk, while the short call strike price creates the upper limit beyond which future stock gains would not boost profitability.
The maximum profit is limited to the difference in strike prices minus the debit paid to open the trade.

Breakeven


If the stock price is greater than the lower strike by the amount of the initial investment, this approach will break even at expiration (the debit).
In that instance, the short call would be worthless, and the intrinsic value of the long call would be equal to the debit.


Long call strike + net debit paid = breakeven.

Volatility


All other things being equal, a smidgeon.
The effects of volatility fluctuations on the two contracts may negate each other to a great degree because the strategy entails being long one call and short another with the same expiration.


However, the stock price can fluctuate in such a way that a change in volatility affects one price more than the other.

Time Passes


The position suffers from the passage of time, but not as much as a simple long call position.
The effects of time decay on the two contracts may negate each other to a substantial degree because the strategy entails being long one call and short another with the same expiration.


Regardless of the potential pricing impact of time erosion on the two contracts, it is reasonable to believe that time is a negative factor.
This technique necessitates a one-time non-refundable investment.
If there are any returns on the investment, they must be realized before the investment expires.
As the deadline for making any profits approaches, so does the deadline for achieving any profits.

Assignment Danger


While early assignment is feasible at any time, it is most common when a stock goes ex-dividend.
Due to the delay in assignment notification, employing the long call to cover the short call assignment will necessitate establishing a short stock position for one business day.


Also, any situation in which a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off, or special dividend, might fundamentally destabilize traditional expectations for early execution of stock options.

Risk of Expiration


Yes.
This method carries additional risk if it is retained until it expires.
The investor will not know whether or not the short call was allocated until the following Monday.
If the stock is trading slightly below, at, or just above the short call strike, the problem is magnified.


Assume the long call is in the money and the short call is almost in the money.
Assignment (stock sale) is uncertain, but exercise (stock buying) is.
If the investor makes a bad guess, the new position on Monday will be incorrect as well.
If assignment is expected but does not occur, the investor will be surprisingly long the stock on Monday, potentially exposing the investor to a weekend decline in the stock.
Assume the investor gambled against assignment and instead sold the stock in the market; if assignment occurs on Monday, the investor will have sold the identical shares twice, resulting in a net short stock position, and will be exposed to a stock price rally.


There are two options for being ready: narrow the spread early or be ready for either outcome on Monday.
In any case, it's critical to keep an eye on the stock, particularly on the last day of trading.